CFA Level II Exam · Intercorporate Investments

Equity Method of Accounting for Investments in Associates

Updated 7 October 2026

The equity method applies when an investor has significant influence over an investee, usually a 20% to 50% voting stake. You record the investment at cost, add your share of the investee's net income, subtract dividends received, and subtract amortization of excess purchase price assigned to undervalued assets. Impairment is tested if value falls.

Understand Equity Method of Accounting for Associates

Start with the idea behind the method. If you own a large stake in a company and can influence its decisions, the investment is more than a passive holding. The equity method reflects this by treating your investment as a claim on a share of the investee's net assets, not as a pile of shares valued at market price.

Significant influence is presumed, not guaranteed, at 20% to 50% of voting power. Other signs include board seats, participation in policy decisions, material transactions between the two firms, exchange of managers and technology dependence. Below 20% can still qualify if these signs exist. Above 20% can fail if the investor is blocked from influence. Control (usually above 50%) leads to consolidation instead.

The investment is first recorded at cost on the balance sheet. After that, the carrying amount rises with your share of the investee's net income and falls with dividends you receive. Dividends are a return of capital, not income, because the share of profit was already recognized. On the income statement you show only one line: share of the associate's profit. The investee's revenues, expenses, assets and liabilities are not added line by line. That is the key contrast with consolidation and proportionate consolidation.

The purchase price often exceeds your share of the investee's book value. This excess is the basis difference. Part of it relates to fair value above book value of identifiable assets such as equipment or inventory. That part is amortized or expensed over the assets' lives, reducing your equity income. The remainder is implied goodwill, which is not amortized and not separately tested. Instead, the whole investment is tested for impairment.

Under IFRS, if there is objective evidence of impairment, you compare the recoverable amount with the carrying amount and write down any shortfall through profit or loss. IFRS allows reversal of the loss if recoverable amount later recovers; US GAAP does not allow reversal. Both frameworks permit a fair value option for the investment. The election is made at initial recognition and is irrevocable. If you elect it, you carry the investment at fair value with changes in profit or loss instead of using the equity method. Under IFRS the election is available to venture capital organisations, mutual funds and similar entities; US GAAP allows it more broadly. Also, if the carrying amount reaches zero because of losses, you stop recording further losses unless you have obligations to fund the investee. Equity income resumes only after your share of later profits recovers the unrecognized losses.

Key formulas to remember

Ending investment balance: Ending = Beginning + Share of net income − Dividends received − Basis difference amortization − Share of unrealized intercompany profit − Impairment loss; Dividends reduce the carrying amount; they are not income. Include only the adjustments the vignette gives you.
Share of net income: Equity income = Ownership % × Investee net income; Reported as one line on the income statement, before adjusting for amortization.
Basis difference: Excess = Purchase price − Ownership % × Book value of investee net assets; Allocate to undervalued identifiable assets first; the remainder is implied goodwill.
Annual amortization of excess: Amortization = (Ownership % × Fair value excess of the asset) ÷ Useful life; Goodwill portion is not amortized.
Reported equity income: Equity income = Share of net income − Amortization of basis difference; This is the amount that increases the investment and appears in profit.
Significant influence presumption: 20% ≤ voting stake ≤ 50%; A presumption only; look at other evidence of influence.
Impairment test: Loss = Carrying amount − Recoverable amount, if carrying amount is greater; IFRS permits reversal later; US GAAP does not.
Unrealized profit elimination (upstream or downstream): Eliminate Ownership % × Unrealized profit on intercompany sales; Reduce equity income until the goods are sold to outsiders.

How to solve Equity Method of Accounting for Associates questions

Use this order for any equity method item set. Read the vignette for the stake, the price, book values, dividends and any intercompany sales.

1Confirm the classification: check the voting stake and signs of significant influence. If influence exists, use the equity method; if control, consolidate.
2Record initial cost as the opening carrying amount, including any basis difference inside it.
3Compute the basis difference: purchase price minus ownership % × book value of net assets. Split it between undervalued assets (with lives) and implied goodwill.
4Compute annual amortization of the asset-specific excess only. Never amortize goodwill.
5Calculate equity income: ownership % × net income, minus amortization, minus your share of unrealized intercompany profit if given.
6Roll the balance forward: add equity income and subtract dividends received (ownership % × total dividends).
7Check for impairment or the fair value option. Compare recoverable amount with carrying amount, or switch to fair value through profit or loss.
8Answer the specific question: investment balance, income, ratios, or comparison with other methods. Use the investor's, not the investee's, figures for ratios.

Quickest way: Balance roll-forward shortcut

When to use it: Use when the question asks only for the ending investment balance or equity income and gives a clear fair value excess.

Write: cost + share of income − dividends − amortization − unrealized profit share − impairment, using only the items given.
Compute amortization as your share of fair value excess ÷ life.
Dividends received are share × dividends declared; do not touch income for them.
Skip goodwill calculations unless impairment or the goodwill amount is asked.
Sanity check: the balance should rise when income exceeds dividends plus amortization.

Common mistakes in Equity Method of Accounting for Associates

Treating dividends received as income
Cost and fair value methods count dividends as income, so candidates carry the habit over.
Fix: Under the equity method, dividends only reduce the carrying amount. Income is your share of profit.
Ignoring basis difference amortization
Candidates compute share of net income and stop.
Fix: Always check if purchase price exceeds share of book value. Amortize the excess tied to depreciable or inventory assets.
Amortizing implied goodwill
The whole excess looks like one number.
Fix: Only fair value excess on identifiable assets is amortized. Goodwill stays in the balance and is covered by impairment testing of the whole investment.
Using 100% of investee figures
Confusion with consolidation or proportionate consolidation.
Fix: Equity method shows one line and one balance sheet asset. Multiply investee net income and dividends by your ownership %.
Assuming impairment can be reversed under both standards
Mixing up IFRS and US GAAP rules.
Fix: IFRS allows reversal if recoverable amount rises; US GAAP does not.
Booking losses below zero
Mechanical subtraction of losses from the balance.
Fix: Stop at zero unless you have guaranteed or committed to fund the investee. Track unrecognized losses and recover them before recognizing new income.

Worked examples

Example 1

On 1 January, Altair Holdings buys 30% of Brenner Corp for €90 million. Brenner's net assets have a book value of €250 million. The only fair value difference is equipment with fair value €40 million above book value, remaining life 10 years. During the year Brenner reports net income of €50 million and pays dividends of €20 million. (1) What is the basis difference? (2) What is equity income for the year? (3) What is the year-end investment balance?

Show the solution

Share of book value = 30% × 250 = €75 million.
Basis difference = 90 − 75 = €15 million.
Equipment excess attributable to Altair = 30% × 40 = €12 million. Amortization = 12 ÷ 10 = €1.2 million per year.
Implied goodwill = 15 − 12 = €3 million, not amortized.
Share of net income = 30% × 50 = €15 million. Equity income = 15 − 1.2 = €13.8 million.
Dividends received = 30% × 20 = €6 million.
Ending balance = 90 + 13.8 − 6 = €97.8 million.

Answer: (1) €15 million; (2) €13.8 million; (3) €97.8 million.

Example 2

Cordova Ltd owns 25% of Delmar Inc, carried at €60 million at the start of the year under the equity method. Delmar reports a net loss of €8 million and pays no dividends. Separately, Delmar sold inventory to Cordova during the year at a profit of €4 million, and Cordova still holds all of it. Cordova reports under IFRS. (1) What is the share of Delmar's loss? (2) What adjustment applies for the unsold inventory? (3) What is the year-end balance?

Show the solution

Share of loss = 25% × 8 = €2 million loss.
Delmar sold to Cordova (upstream sale). Unrealized profit is €4 million, all unsold.
Cordova's share of the unrealized profit = 25% × 4 = €1 million, which is eliminated as a separate adjustment to equity income.
Equity result = −€2 million (share of loss) − €1 million (unrealized profit elimination) = −€3 million.
Ending balance = 60 − 3 = €57 million.
No dividends, so no further reduction; the balance is above zero so losses are fully recognized.

Answer: (1) €2 million loss; (2) eliminate €1 million of unrealized profit, so the equity result is −€3 million; (3) €57 million.

Exam tips

Scan the vignette for ownership %, purchase price, book value of net assets, asset lives and dividends before calculating anything.
Many questions test the effect on ratios. Net income and shareholders' equity are the same under the equity method and consolidation (parent's share). Assets, liabilities and revenue are lower under the equity method. So leverage ratios are lower (better) and ROA is higher, because net income is the same on a smaller asset base. Net profit margin is higher because revenue is lower. Asset turnover is ambiguous: it depends on the figures, so do not assume a direction.
Know the contrasts: equity method gives one-line income, proportionate consolidation adds share of each line, and consolidation adds 100% with non-controlling interest.
Watch the IFRS versus US GAAP clue on impairment reversal and fair value option.
Check whether intercompany sales are upstream or downstream and whether the goods are still unsold at year end.

Equity Method of Accounting for Associates: frequently asked questions

How do I calculate the equity method investment balance?

Start with the beginning balance (cost in year one). Add your ownership percentage of the investee's net income, then subtract your share of dividends, amortization of the basis difference on undervalued assets, your share of unrealized intercompany profit, and any impairment loss.

What is the difference between the equity method and proportionate consolidation?

Under the equity method you show one asset and one income line. Under proportionate consolidation you add your share of each asset, liability, revenue and expense line by line. Net income and equity are the same, but assets, liabilities and revenue are higher under proportionate consolidation. Under IFRS, proportionate consolidation is not permitted for joint ventures, which use the equity method.

Is goodwill amortized under the equity method?

No. Implied goodwill sits inside the investment balance and is not amortized or tested separately. The whole investment is tested for impairment when there is evidence of loss.

When can I use the fair value option for an associate?

The election lets you carry the investment at fair value through profit or loss instead of using the equity method. It is made at initial recognition. Under IFRS it is for venture capital organisations, mutual funds and similar entities, while US GAAP allows it more broadly.